US Markets Kick Off 2026: Defense Drives Dow, Tech Faces Pressure

The U.S. equity market began 2026 with strong divergence across indexes. The Dow’s best 5-day start since 2006 reflects investor enthusiasm toward sectors expected to benefit from policy shifts—most notably defense and heavy industry. That rally was driven by a proposed doubling of defense spending to $1.5 trillion in fiscal 2027, a massive increase from the $901 billion approved for 2026, which directly boosted defense names like Lockheed Martin, Northrop Grumman, RTX, and Kratos Defense. Simultaneously, optimism in financials and industrials supported broader cyclicals.

Meanwhile, the S&P 500’s flat close and the Nasdaq’s decline underscore risk aversion toward stretched valuations in growth and AI-related stocks. Comments about “AI fatigue” and profit‐taking in richly valued tech names such as Meta, Apple, and Oracle drove the underperformance in those indexes. The Russell 2000’s new record close suggests strength among small caps, likely supported by domestic cyclicals and expectations for infrastructure and defense procurement tailwinds.

The labor market data for December delivered a disappointing headline figure—50,000 jobs added and an unemployment rate falling to 4.4% from November’s 4.5%. While that marks weakness in job creation, the drop in unemployment adds complexity: either participation fell, or the labor force conditions tightened in other ways. The full-year gain of 584,000 jobs makes 2025 the weakest non-recession year of job growth since 2003. Key sectors like health care and social assistance showed resilience, while manufacturing, construction, and retail dragged.

These mixed signals shift expectations for policy: markets widely anticipate that the Federal Reserve will leave its policy rates unchanged in its January meeting, given the modest payroll gains and lack of inflation cooling so far. There is still potential for rate cuts later in 2026, contingent upon further easing in labor market conditions and inflation metrics holding steady or declining. Risk remains elevated: underwhelming economic momentum may either stall growth or, if inflation remains sticky, force the Fed to keep its fingers on the brake longer.

Strategic implications:

• Investors are rotating toward value and industrial plays—especially defense contractors—expecting policy support; growth/technology stocks may underperform until valuation concerns are addressed.
• Bonds yields and inflation trends will be watched closely; a failure to ease inflation could delay rate cuts and weigh on risk assets.
• Small caps and sectors dependent on government spending stand to benefit; conversely, discretionary growth and export-exposed tech could face headwinds in a high‐cost capital environment.
• Monitoring labor force participation, quits rate, and job openings will be critical to assess whether unemployment drops reflect real strength or underlying labor market softening.